Arab spring and Japanese winter

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Two exogenous shock-waves have struck markets in the past few weeks: the first, social and political, stemming from the democratic uprisings in North Africa and the Middle East; the second, seismic and nuclear, with the devastating earthquake and tsunami, and the crippled Fukushima nuclear plant in Japan. These events have unfolded against a still bright backdrop for markets in terms of both macroeconomic developments and corporate news. Companies have been reporting excellent results, and confidence has been restored, reflected in rising investment and increasing M&A activity. However, these positives did not prevent equity markets from losing ground from their mid-February highs, with falls of between 7% on the S&P 500 and 25% on the Nikkei.

The twin shocks have nothing in common except that they are exogenous. In the short-to-medium term, their repercussions for financial markets are likely to be fundamentally different. Market reactions in Japan to the problems in controlling the damaged Fukushima nuclear reactors verged on panic which, in the very near term, did throw up some attractive buying opportunities. Whatever the final outcome of the natural disaster and its ramifications for Japan’s economy, a contraction of over 20% in Japan’s market capitalisation was plainly not warranted. Events have highlighted once again that low share valuations do not offer protection against severe short-term losses. Despite Japanese equities being valued at just 1X book value with an expected return of over 15% annually, sizeable losses have been incurred.